Examining role of IL&FS auditors long overdue

Auditors knew there were hundreds of subsidiaries in which debt was parked but never highlighted this.

IL&FS had 347 entities that were held via four levels of step-down subsidiaries and there were 142 entities at Level 4.

The government has done well to tell the National Company Law Tribunal (NCLT) that it plans to reopen the accounts of IL&FS since it suspects large auditor lapses; whether these were genuine or not remains to be seen. The probe by the Serious Frauds Investigation Office (SFIO), the government said, indicated that the accounts were fraudulent. In a parallel probe, the CA institute (ICAI) has sent a formal notice to the partners of three audit firms to begin an investigation into their audits. The problem here, of course, is that while ICAI can penalise the members who did the audit, it can take no action against the firms under whose banner they work. Given that the auditor fees paid by IL&FS rose from Rs 4.5 crore in FY15 to Rs 15.9 crore in FY17, before falling to Rs 13.7 crore in FY18, it is truly worrying that the auditors never flagged issues at IL&FS for all these years.

A large part of the problem stems from the fact that the Indian law allows too many layers of subsidiaries; IL&FS had 347 entities that were held via four levels of step-down subsidiaries and there were 142 entities at Level 4. The modus operandi seems to have been to keep the parent accounts clean while keeping the debt in the subsidiaries. Nor, so far, has the government agreed that one entity audit the accounts of the entire group, including subsidiaries; presumably this will be seen to be favouring the bigger audit firms as only they have the manpower to audit really big firms with a large number of subsidiaries. In which case, chances are the first line of defence of the audit firms will be that they didn’t audit the accounts of the subsidiaries and so cannot be held accountable for the gaps in those accounts.

While that is valid at a certain level, it also remains true that the auditors didn’t do justice with even what they had. The IL&FS annual report for 2018, for instance, gives the company’s net profits of Rs 584 crore for the year within the first few pages, but it takes till the 210th page to know that group incurred a net loss of Rs 1,869 crore that year. And while the company’s borrowings are Rs 15,935 crore, it is only in the consolidated balance sheet—also in the annual report—that you get to know the group debt is Rs 106,483 crore. And before reporting this, the auditor says there are 141 subsidiaries, 12 associates and 26 joint ventures whose accounts were audited by other firms and, in addition, it did not audit the financial statements of 18 subsidiaries, 6 associates and 17 joint ventures. Surely if the auditor knew there were such a large number of subsidiaries and related entities where close to Rs 90,000 crore of debt was parked, it needed to flag this? Certainly, then, the rosy financial ratios the annual report gives would have changed significantly.

The SFIO probe, and the reopening of accounts will also help find if there was siphoning off of funds—in less than a month of taking over, the Kotak panel reported an instance of an asset being transferred from one group entity to another at Rs 31 crore and then, a year later, being sold to a third party for Rs 1 crore. Also, as the Kotak panel had informed NCLT, the investments of IL&FS Financial Services in group arms was significantly in excess of RBI norms. While it is true that some changes in the law are required—mandatorily reporting some group-level financial ratios while giving individual company data, for instance—it is only when tough action is taken against auditors, rating agencies and the directors of firms, that there can be some hope that such blatant irregularities won’t take place in the future; so far, no action has been proposed when it comes to IL&FS directors.